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Buy Down Mortgages
Buy Down Mortgages
A Buy Down Mortgage is a mortgage that allows the borrower to "buy down" the interest rate for set periods of time. Usually, a large sum of money is placed in an escrow account which is used to supplement the borrower's monthly payments. One way to look at this is pre-paying interest. Typical Buy Down Mortgages include 3-2-1, 2-1 and 1-0 buy downs. A 3-2-1 buy down requires the most up front to be put into the escrow account. For the first period the interest bought down 3%. Then in the following periods the interest rises to 2% below and 1% below the fixed rate respectively. In the final period the interest rate rises to the fixed rate and stays at that for the remainder of the loan term. The same applies to the 2-1 and 1-0 buy downs except there are less buy down periods.
The person that pays for the buy down differs in individual circumstances. The seller of a home can pay for a buy down as an incentive to purchase the house, a lender can pay for the buy down as a means of negotiating a higher fixed interest rate for the life of the loan or the borrower can pay for the buydown as a means to qualify for the mortgage. In either event both parties benefit. The seller sells their home and the lender receives a higher fixed interest rate than they normally would. The borrower, on the other hand, is able to purchase the home and have a reduced interest rate and monthly payment for the initial period of the mortgage.
At first glance, a Buy Down Mortgage doesn't seem beneficial. Why pay interest before it's due? Think of it as qualifying for money to put towards a house. With a Buy Down Mortgage you're also buying down your monthly payment. In turn, this allows you to buy a more valuable house because you only have to qualify to make the intial payment. This is extremely valuable in situations where a borrower has come into a lump sum of money (inheritance, one time gift, etc.). That money can be applied to a Buy Down Mortgage, the borrower can purchase a more expensive house than they would have and have reduced payments for three years. The kicker in this scenario is when the payment increases. It's imperative that the borrower's income increases during within this period or the house is sold. Otherwise, the borrower is stuck with a higher payment that they might not be able to afford after the buydown period is over.